OKE Precision Cutting Tools' (SHSE:688308) Weak Earnings Might Be Worse Than They Appear

OKE Precision Cutting Tools Co., Ltd.'s (SHSE:688308) weak earnings were disregarded by the market. While shares were up, we believe there are some factors in the earnings report that might cause investors some concerns.

Check out our latest analysis for OKE Precision Cutting Tools

A Closer Look At OKE Precision Cutting Tools' Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to December 2023, OKE Precision Cutting Tools recorded an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Over the last year it actually had negative free cash flow of CN¥451m, in contrast to the aforementioned profit of CN¥166.0m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥451m, this year, indicates high risk. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that OKE Precision Cutting Tools' profit was boosted by unusual items worth CN¥33m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On OKE Precision Cutting Tools' Profit Performance

Summing up, OKE Precision Cutting Tools received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue OKE Precision Cutting Tools' profits probably give an overly generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 3 warning signs for OKE Precision Cutting Tools (1 is a bit concerning!) and we strongly recommend you look at them before investing.

Our examination of OKE Precision Cutting Tools has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.